Since 2012, and the passage of the JOBS Act, which loosened restrictions on how and from whom companies can raise money, equity crowdfunding has been a viable option for U.S.-based startups and small businesses. In just a few years, the volume of fund raised worldwide with these platforms strongly increased to reach $4 billion in 2016 ; and it is forecast that equity crowdfunding would surpass standard venture capital and business angel models within 2020. More than a threat, this emerging new model could represent an opportunity for financial institutions as well as Asset managers.
Crowdfunding: several concepts
Crowdfunding started with donation or reward-based models. But rapidly, it has been expanded to investment-based models between consumers and businesses. The model which particularly interests the asset management industry is equity crowdfunding, or crowd-equity (and, to a lesser extent, real-estate), which principle is to offer stock or convertible debt instruments in payment of accredited investors’ contribution.
Traditionally it was difficult for entrepreneurs and start-up businesses to access investors with enough money. The equity crowdfunding platforms have changed that. By using new technologies they provide businesses seeking a greater visibility of investment to a crowd of people with money to invest from across the country and in some cases professional investors as well.
For investors, equity crowdfunding platforms provide a structure from which they can look at businesses in which they may wish to invest, keep track of their investments and more easily access tax wrappers like Enterprise Investment Schemes (EIS) and Seed Enterprise Investment Schemes (SEIS) that offer tax incentives that can make investment in smaller and start-up companies more attractive.
The companies raising money from the crowd are usually not yet listed on a stock market. However, the market is starting to change with – for instance – the raising of £10.7 million for AIM-listed [1] businesses in UK last year.
A rapid growth
In 2015, the total equity crowdfunding volume worldwide was $2.56 billion [1], and it was estimated at $4 billion in 2016. That number has been roughly doubling each year since 2012. Based on these numbers, Forbes is projecting that equity crowdfunding may surpass standard venture capital models (currently at $20 billion per year) and business angels ($30bn p.y.) in volume by 2020. These numbers are backed up by the World Bank, which sees the crowdfunding market as a whole continuing to double annually and hit $90 billion in volume by 2020.
The U.S. continue to be one of the world’s top markets for advanced, technology-enabled, online alternative finance channels and instruments. The 2016 U.S. market volume of $34.5 billion marked a 22% year-on-year increase from 2015. Equity-based crowdfunding reached $569.5 million (representing 1.6% of the entire Americas market).
Crowdfunding and equity crowdfunding is growing fast in Europe. In 2015, €354 million in equity was raised [3], an increase of 92% from 2014, with an average of between €459,000 and €488,619 per campaign in 2015. The UK is the main contributor with £245 million (excluding real estate) [4]. With 15.6% of all seed and venture capital investing, equity-based crowdfunding is currently the second most active funding source in the UK [5]. And the two main actors (Crowdcube & Seedrs) accounted alone for 21% per cent of non-listed high-growth investments in 2016. France is the second market in Europe with €58 million raised in 2017 ; Germany completes the podium with €38 million.
Threat or opportunity for AM industry?
It is undeniable that these platforms have taken a significant market share and carry many advantages for issuers and investors, compared with venture capital (VC). Some of them - like Lendix or Tikehau - have even launched funds opened to institutional investors in the form of an ELTIF [6] dedicated to lending to SMEs. At first sight, they could be consider as new competitors. But, they rather appear as complementary.
First, the two financing methods are not so in competition. They are two sides of the same coin, depending on the funding’s size and the company’s objectives. Thus, VCs gives companies credibility among their peers, customers and the wider startup ecosystem. Working with VCs can position startups for rapid growth and acquisition.
Second, they are not mutually exclusive. Many startups seeking capital are successfully inviting VCs to participate in equity crowdfunding as lead investors. According to Jeff Lynn, CEO of Seedrs, “institutional capital begins to play a meaningful role in equity crowdfunding.” This is a win-win situation which combines the expertise of smart money with a diversified book of retail investors.
Third, like robo-advisory, trend goes now more to partnership than disruptive competition. Collaboration has recently emerged between financial institutions and equity crowdfunding platforms, enhancing the services offered to investors:
- In the UK, Seedrs and NatWest have become partners, to provide access to capital to British SMEs ;
- JP Morgan has partnered with Lending Club in the US, while General Mills’ venture arm invested directly on CircleUp ;
- In France, just after the takeover of KissKissBankBank by La Banque Postale, Tikehau Capital announced the acquiring of Credit.fr, a crowdlending specialist, for €12 million ;
- In the Netherlands, Rabobank and Knab have cooperated to facilitate entrepreneurs financing, through a crowdfunding platform powered by Collin Crowdfund ;
- In Portugal, Banco BNI Europa has joined Raize through a €10 million boost targeted at increasing SME lending ;
- Singapore-based, United Overseas Bank (UOB) tied up with OurCrowd, an Israeli Fintech, to allow its SME clients to obtain funds through its equity crowdfunding platform.
These moves happened together with a consolidation of the crowdfunding industry. In the UK, the five largest platforms accounted for 64% of total market volume in 2016, providing some evidence that this is an increasingly concentrated marketplace. There were fewer new entrants into the market, and more than 35 UK online alternative finance platforms became inactive in 2016 through mergers or close-downs.
“As market consolidation accelerates there is greater pressure on alternative finance platforms to distinguish themselves through better services and more innovative products, whilst simultaneously responding to emerging regulatory and supervisory demands.” Bryan Zhang, Executive Director of the Cambridge Centre for Alternative Finance.
The big market trends seem to be established, with a favorable forecast evolution of the regulation. Crowdfunding platforms are now an integral part of the fundraising landscape and the partnerships with financial institutions demonstrate that it will soon be inevitable in asset manager's service offerings. The next challenge they have to face may emerge from the integration of Blockchain technology in equity crowdfunding platforms, as Crowd-up has developed, proposing a decentralized funding to businesses which want to raise capital. To be continued.
Author: Pascal Buisson - March 2018
[1] Alternative Investment Market (submarket of the London Stock Exchange) - [2] Massolution Crowdfunding Industry Report, 2016 - [3] Cambridge centre for Alternative Finance, 2017 - [4] Pushing Boundaries, The 2015 UK Alternative Finance Industry Report, University of Cambridge - [5] Beauhurst, 2016 - [6] European Long Terme Investment Fund
